Goals from Marlon King, Ashley Young and Matthew Spring gives Watford a three-goal advantage at this halfway stage in the semi-final.
Palace were left counting the cost of some poor finishing after dominating the first half.
But Adrian Boothroyd's men were resurgent after the break and Watford romped on to win the match and virtually killed off Palace's hopes of a swift return to the Premiership.
Watford nearly opened the scoring in the seventh minute when Tony Popovic failed to clear a hopeful long punt into the box by Ben Foster.
But King's shot was well saved by Gabor Kiraly, who had sprinted off his goal-line.
That moment provided the wake-up call Palace needed, who turned up the heat on Watford. Jobi McAnuff first danced his way into the box but his shot was well saved by Foster.
Andrew Johnson then nearly broke the deadlock in the 16th minute but dragged his shot agonisingly wide of the post after Ben Watson had supplied the pass.
Jay DeMerit then had to be on guard to hack Tom Soares' teasing cross away to safety before Clinton Morrison fired over the bar from 14 yards after Johnson had dummied McAnuff's pass.
Watson then tried his luck from distance as Palace looked to take advantage of their long spells of possession. But the midfielder's shot from the edge of the area was again off target.
Just before the break Watford enjoyed their best spell of possession by failed to carve out any real chance to take the lead.
That all changed however, in the first minute of the second half when King put Watford in front.
Foster's long goal kick again proved too difficult for the Palace defence as this time Darren Ward failed to cope.
The former Millwall defender was out-muscled by King who then pulled off a neat turn before firing a low shot past Kiraly.
The goal was a sucker-punch for Palace who became unsettled by the goal, but things got worse for Palace as Young made it 2-0 in the 67th minute.
The former Arsenal trainee scored his 15th goal of the season with an exquisite free-kick from 25-yards out which sailed past Kiraly, who was left fuming at his defence.
Spring then put the result beyond doubt with Watford's third five minutes from full-time.
He picked up the ball from Young before nipping inside Fitz Hall and firing past Kiraly, leaving Palace needing a miracle if they are to reach the play-off final in Cardiff.